This appendix explains a parsimonious method to obtain forecast for net operating profit after tax (NOPAT) and for net operating assets (NOA). This method requires three crucial inputs: 1. Sales growth. 2. Net operating profit margin (NOPM); Defined in Module 4 as NOPAT divide by sales. 3. Net operating asset turnover (NOAT); defined in Module 4 as sales divide by average NOA. (For forecasting purposes, we define NOAT as sales divide by year-end NOA instead of average NOA because we want to forecast year-end values.) Multiyear Forecasting with Parsimonious Method We use Procter \& Gamble's 2016 income statement from Exhibit 12.2, and its 2016 balance sheet form Exhibit 12.3, to determine the following measures. We assume that P\&G's statutory tax rate is 37% on nonoperating revenues and expenses. - we use ending balance sneet amounts, rather than average amounts, because we torecast ending balance ending balance sheet amounts. Each year's forecasted sales is the prior year sales multiplied successively by ( 1+ growth rate) and then rounded to whole digits. Consistent with our prior revenue growth rate assumption for P&G. we define "1+ growth rate" as 1.01 for 2017 and 1.02 for 2018 onward. NOPAT is computed using we define " 1+ growth rate" as 1.01 for 2017 and 1.02 for 2018 onward. NOPAT is computed using forecasted (and rounded) sales each year times the 2016 NOPM of 15.4%; and NOA is computed using forecasted (and rounded) sales divided by the 2016 NOAT of 0.93. Forecasted numbers for 2017 through 2020 are in Exhibit 12B.1; supporting computations are in parentheses. This forecasting process can be continued for any desired forecast horizon. Also, the forecast assumption such as sales growth, NOPM, and NOAT can be varied by year, if desired. This parsimonious method is simpler than the method illustrated in this method. However, its simplicity foregoes information than can improve forecast accuracy. Exhibit 12B. I P\&G Parsimonious Method Forecasts of Sales, NOPAT and NOA Forecasted NOPAT = Forecasted net sales (rounded) 2016 NOPM 2 Forecasted NOA = Forecasted net sales ( rounded )2016 NOAT DuPont Analysis, Forecasting with the Parsimonious Method and Estimating Share Value of Cisco Systems Inc Using the DCF Model Cisco Systems, Inc. is a multinational information technology company headquartered in San Jose, California, that produces and sells networking hardware, telecommunications equipment and other high-technology services. Cisco Systems was founded in December 1984 by Leonard Bosack and Sandy Lerner, two Stanford University computer scientists, who pioneered the concept of a local area network (LAN). In 1990, Cisco Systems went public with a market capitalization of $224 million. By 2000, Cisco had become the most valuable company in the world with a more than $500 billion market capitalization. The stock was initially listed on the NASDAQ in 1990, and then was added to the Dow Jones Industrial Average on June 8, 2009. Cisco is currently included in the S\&P 500 Index, the Russell 1000 Index, NASDAQ-100 Index and the Russell 1000 Growth Stock Index. 1 As Figure 1 shows, the stock price of Cisco Systems peaked in 1999-2000 before the burst of internet bubble. However, its stock price has been fluctuating in the range of $10$30 since 2001. Following are the income statement and balance sheet for Cisco Systems for the year ended y 303n16 \begin{tabular}{|lll|} \hline Interest and other income (10ss), net & 260 & 431 \\ Income before provision for income taxes & 12,920 & 11,201 \\ Provision for income taxes & 2,181 & 2,220 \\ \hline Net income & $10,739 & $8,981 \\ \hline \end{tabular} 2 Cisco- Systems Inc. Consolidated Balance Sheets In millions, except par value July 30, 2016 July 25,2015 Assets Assets Current assets Cash and cash equivalents Investments Accounts receivable, net of a at July 30,2016 and $302 at Inventories Financing receivables, net Other current assets Other current assets Total current assets Property and equipment, net Financing receivables, net Poodwill Deferred tax assets Other assets Total assets Liabilities Current liabilities Short-term debt Accounts payable Income taxes payable Accrued compensation Deferred revenue Other current liabilities Total current liabilities Long-term debt \begin{tabular}{ll|} $4,160 & $3,897 \\ 1,056 & 1,104 \\ 517 & 62 \\ 2,951 & 3,049 \\ 10,155 & 9,824 \\ 6,072 & 5,476 \\ 24,911 & 23,412 \\ 24,483 & 21,457 \\ \hline \end{tabular} \begin{tabular}{lll} Long-term debt & 24,483 & 21,457 \\ Income taxes payable & 925 & 1,876 \\ Deferred revenue & 6,317 & 5,359 \\ Other long-term liabilities & 1,431 & 1,562 \\ Total liabilities & 58,067 & 53,666 \\ \hline \end{tabular} 3 Cisco Systems Inc. Consolidated Balance Sheets In millions, except par value July 30, 2016 July 25, 2015 Cisco shareholders' equity Preferred stock, no par value: 5 shaes authorized; none issued and outstanding Common stock and additional paid-in canital. 50.001 par value: Common stock and additional paid-in capital, $0.001 par value: 20,000sharesauthorized;5,029and5,085sharesissuedandoutstandingatJuly30,2016andJuly25,2015,respectivelyRetainedearningsAccumulatedothercomprehensiveincome(loss)TotalCiscoshareholdersequityNoncontrollinginterestsTotalequityTotalliabilitiesandequity44,51619,396326)63,586(1)63,585$121,65243,59216,0456159,698959,707$113,373 (d) Compute net operating profit after tax (NOPAT) for 2016, assuming a federal and state statutory tax rate of 37%. (Round your answer to the nearest whole number.) (9 points) (e) Forecast Cisco's sales, NOPAT, and NOA for years 2017 through 2020 and the terminal period using the following assumptions: (12 points) Assume a discount rate (WACC) of 10%, common shares outstanding of 5,029 million, and net nonoperating obligations ( NNO) of $(37,113) million (NNO is negative which means that Cisco has net nonoperating investments). (f) Estimate the value of a share of Cisco common stock as of July 30, 2016 using the discounted cash flow (DCF) model and sales, NOPAT and NOA forecast in (e); (12 points) (g) If Cisco's top management were optimistic about CISCO's market growth opportunities and revised their sales growth rates up by 5%, please forecast Cisco's sales, NOPAT, and NOA for years 2017 through 2020 and the terminal period using the following assumptions: (8points) (h) Estimate the value of a share of Cisco common stock as of July 30, 2016 using the discounted cash flow (DCF) model and the forecast in (g); Note, still assume a discount rate (WACC) of 10%, common shares outstanding of 5,029 million, and net nonoperating obligations (NNO) of $(37,113) million. ( 8 points) (i) Cisco stock closed at $31.47 on September 8, 2016, the date the Form 10-K was filed with the SEC. How does your DCF valuation estimates compare with this closing price? What do you believe are some reasons for the difference? What investment decision is suggested from your results? ( 10 points) (j) Are there other equity valuation models? Please discuss the advantages and disadvantages of different equity valuation models. ( 15 points) This appendix explains a parsimonious method to obtain forecast for net operating profit after tax (NOPAT) and for net operating assets (NOA). This method requires three crucial inputs: 1. Sales growth. 2. Net operating profit margin (NOPM); Defined in Module 4 as NOPAT divide by sales. 3. Net operating asset turnover (NOAT); defined in Module 4 as sales divide by average NOA. (For forecasting purposes, we define NOAT as sales divide by year-end NOA instead of average NOA because we want to forecast year-end values.) Multiyear Forecasting with Parsimonious Method We use Procter \& Gamble's 2016 income statement from Exhibit 12.2, and its 2016 balance sheet form Exhibit 12.3, to determine the following measures. We assume that P\&G's statutory tax rate is 37% on nonoperating revenues and expenses. - we use ending balance sneet amounts, rather than average amounts, because we torecast ending balance ending balance sheet amounts. Each year's forecasted sales is the prior year sales multiplied successively by ( 1+ growth rate) and then rounded to whole digits. Consistent with our prior revenue growth rate assumption for P&G. we define "1+ growth rate" as 1.01 for 2017 and 1.02 for 2018 onward. NOPAT is computed using we define " 1+ growth rate" as 1.01 for 2017 and 1.02 for 2018 onward. NOPAT is computed using forecasted (and rounded) sales each year times the 2016 NOPM of 15.4%; and NOA is computed using forecasted (and rounded) sales divided by the 2016 NOAT of 0.93. Forecasted numbers for 2017 through 2020 are in Exhibit 12B.1; supporting computations are in parentheses. This forecasting process can be continued for any desired forecast horizon. Also, the forecast assumption such as sales growth, NOPM, and NOAT can be varied by year, if desired. This parsimonious method is simpler than the method illustrated in this method. However, its simplicity foregoes information than can improve forecast accuracy. Exhibit 12B. I P\&G Parsimonious Method Forecasts of Sales, NOPAT and NOA Forecasted NOPAT = Forecasted net sales (rounded) 2016 NOPM 2 Forecasted NOA = Forecasted net sales ( rounded )2016 NOAT DuPont Analysis, Forecasting with the Parsimonious Method and Estimating Share Value of Cisco Systems Inc Using the DCF Model Cisco Systems, Inc. is a multinational information technology company headquartered in San Jose, California, that produces and sells networking hardware, telecommunications equipment and other high-technology services. Cisco Systems was founded in December 1984 by Leonard Bosack and Sandy Lerner, two Stanford University computer scientists, who pioneered the concept of a local area network (LAN). In 1990, Cisco Systems went public with a market capitalization of $224 million. By 2000, Cisco had become the most valuable company in the world with a more than $500 billion market capitalization. The stock was initially listed on the NASDAQ in 1990, and then was added to the Dow Jones Industrial Average on June 8, 2009. Cisco is currently included in the S\&P 500 Index, the Russell 1000 Index, NASDAQ-100 Index and the Russell 1000 Growth Stock Index. 1 As Figure 1 shows, the stock price of Cisco Systems peaked in 1999-2000 before the burst of internet bubble. However, its stock price has been fluctuating in the range of $10$30 since 2001. Following are the income statement and balance sheet for Cisco Systems for the year ended y 303n16 \begin{tabular}{|lll|} \hline Interest and other income (10ss), net & 260 & 431 \\ Income before provision for income taxes & 12,920 & 11,201 \\ Provision for income taxes & 2,181 & 2,220 \\ \hline Net income & $10,739 & $8,981 \\ \hline \end{tabular} 2 Cisco- Systems Inc. Consolidated Balance Sheets In millions, except par value July 30, 2016 July 25,2015 Assets Assets Current assets Cash and cash equivalents Investments Accounts receivable, net of a at July 30,2016 and $302 at Inventories Financing receivables, net Other current assets Other current assets Total current assets Property and equipment, net Financing receivables, net Poodwill Deferred tax assets Other assets Total assets Liabilities Current liabilities Short-term debt Accounts payable Income taxes payable Accrued compensation Deferred revenue Other current liabilities Total current liabilities Long-term debt \begin{tabular}{ll|} $4,160 & $3,897 \\ 1,056 & 1,104 \\ 517 & 62 \\ 2,951 & 3,049 \\ 10,155 & 9,824 \\ 6,072 & 5,476 \\ 24,911 & 23,412 \\ 24,483 & 21,457 \\ \hline \end{tabular} \begin{tabular}{lll} Long-term debt & 24,483 & 21,457 \\ Income taxes payable & 925 & 1,876 \\ Deferred revenue & 6,317 & 5,359 \\ Other long-term liabilities & 1,431 & 1,562 \\ Total liabilities & 58,067 & 53,666 \\ \hline \end{tabular} 3 Cisco Systems Inc. Consolidated Balance Sheets In millions, except par value July 30, 2016 July 25, 2015 Cisco shareholders' equity Preferred stock, no par value: 5 shaes authorized; none issued and outstanding Common stock and additional paid-in canital. 50.001 par value: Common stock and additional paid-in capital, $0.001 par value: 20,000sharesauthorized;5,029and5,085sharesissuedandoutstandingatJuly30,2016andJuly25,2015,respectivelyRetainedearningsAccumulatedothercomprehensiveincome(loss)TotalCiscoshareholdersequityNoncontrollinginterestsTotalequityTotalliabilitiesandequity44,51619,396326)63,586(1)63,585$121,65243,59216,0456159,698959,707$113,373 (d) Compute net operating profit after tax (NOPAT) for 2016, assuming a federal and state statutory tax rate of 37%. (Round your answer to the nearest whole number.) (9 points) (e) Forecast Cisco's sales, NOPAT, and NOA for years 2017 through 2020 and the terminal period using the following assumptions: (12 points) Assume a discount rate (WACC) of 10%, common shares outstanding of 5,029 million, and net nonoperating obligations ( NNO) of $(37,113) million (NNO is negative which means that Cisco has net nonoperating investments). (f) Estimate the value of a share of Cisco common stock as of July 30, 2016 using the discounted cash flow (DCF) model and sales, NOPAT and NOA forecast in (e); (12 points) (g) If Cisco's top management were optimistic about CISCO's market growth opportunities and revised their sales growth rates up by 5%, please forecast Cisco's sales, NOPAT, and NOA for years 2017 through 2020 and the terminal period using the following assumptions: (8points) (h) Estimate the value of a share of Cisco common stock as of July 30, 2016 using the discounted cash flow (DCF) model and the forecast in (g); Note, still assume a discount rate (WACC) of 10%, common shares outstanding of 5,029 million, and net nonoperating obligations (NNO) of $(37,113) million. ( 8 points) (i) Cisco stock closed at $31.47 on September 8, 2016, the date the Form 10-K was filed with the SEC. How does your DCF valuation estimates compare with this closing price? What do you believe are some reasons for the difference? What investment decision is suggested from your results? ( 10 points) (j) Are there other equity valuation models? Please discuss the advantages and disadvantages of different equity valuation models. ( 15 points)